Key Takeaways
- • Cambridge Associates, an independent investment manager with nearly $500 billion in assets under management and advisory (ILS-related AUM of about $73 billion per the article), is constructive on insurance-linked securities (ILS) for 2023, citing higher yields relative to risk.
- • Cambridge Associates analysts Christine Farquhar and Joseph Tolen describe 2023 as "a market dislocation and opportunity to invest in a diversifying asset on attractive historic yields."
- • The firm recommends a balanced allocation across catastrophe bonds and collateralized reinsurance, and prefers managers that are independent or have limited conflicts with parent balance sheets.
- • Cambridge Associates favors natural catastrophe exposures, such as property catastrophe reinsurance, and sees man-made risks including cyber, shipping and aviation as less well rewarded for their lack of transparency.
- • The firm cautions that ILS must be reviewed regularly, citing climate-related weather risk and the "lack of underwriting discipline" in Florida as factors behind rising yields.
Summary
Cambridge Associates LLC is bullish on insurance-linked securities for 2023, arguing that the higher yields now on offer provide a favorable return opportunity relative to risk. The firm, which has assets under management and advisory approaching $500 billion, sees diversification as essential for investors heading into a period of continued macro uncertainty. Thomas O'Mahony, Investment Director in Capital Markets Research, said that more diversified portfolios have historically delivered higher returns with lower volatility than the classic balanced portfolio.
In a note from Christine Farquhar, Global Co-Head of the Credit Investment Group, and Joseph Tolen, Investment Director for Credit Investments, the firm said ILS has been "weakly correlated" with equities and bonds over the last 15 years, which has demonstrated its diversifying benefits. Yields began rising through 2022, partly in response to regulatory pressures and conditions in Florida, which the analysts characterized as "a lack of underwriting discipline" in the state. They expect this back-up in yields to translate into strong performance.
The analysts caution that investors should review the asset class regularly, given the risks posed by climate change. More frequent weather events and more severe loss outcomes have already pushed yields higher, and managers are factoring these developments, along with increased general claims inflation, into security selection. Managers are described as more careful in choosing insurance counterparties in Florida and in limiting exposure to aggregate contracts, which are more exposed to high-frequency events such as wildfires, hailstorms and tornadoes.
The firm's view is not uniform across the ILS market. Cambridge Associates recommends combining catastrophe bonds and collateralized reinsurance, which it believes is "best placed to deliver optimal reward for well-managed risk," while noting that portfolios must be carefully constructed to limit tail risk from major events. It favors experienced managers with transparent track records and limited conflicts with parent company balance sheets, and is most constructive on natural catastrophe risks such as property catastrophe reinsurance. Man-made risks, including cyber, shipping and aviation losses, are generally not as well rewarded for less transparent risk, the analysts said.
In a note from Christine Farquhar, Global Co-Head of the Credit Investment Group, and Joseph Tolen, Investment Director for Credit Investments, the firm said ILS has been "weakly correlated" with equities and bonds over the last 15 years, which has demonstrated its diversifying benefits. Yields began rising through 2022, partly in response to regulatory pressures and conditions in Florida, which the analysts characterized as "a lack of underwriting discipline" in the state. They expect this back-up in yields to translate into strong performance.
The analysts caution that investors should review the asset class regularly, given the risks posed by climate change. More frequent weather events and more severe loss outcomes have already pushed yields higher, and managers are factoring these developments, along with increased general claims inflation, into security selection. Managers are described as more careful in choosing insurance counterparties in Florida and in limiting exposure to aggregate contracts, which are more exposed to high-frequency events such as wildfires, hailstorms and tornadoes.
The firm's view is not uniform across the ILS market. Cambridge Associates recommends combining catastrophe bonds and collateralized reinsurance, which it believes is "best placed to deliver optimal reward for well-managed risk," while noting that portfolios must be carefully constructed to limit tail risk from major events. It favors experienced managers with transparent track records and limited conflicts with parent company balance sheets, and is most constructive on natural catastrophe risks such as property catastrophe reinsurance. Man-made risks, including cyber, shipping and aviation losses, are generally not as well rewarded for less transparent risk, the analysts said.
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